How fitting that on April Fool’s Day, the Egyptian government attempts to deceive us all by claiming that its plans to raise the price of state-subsidised cooking gas for the first time in two decades will actually make any difference to the country’s energy subsidy spending.
In fact, it won’t, and it is unlikely that the IMF delegation visiting Cairo this week will see it this way.
According to Reuters:
The government increased the price of cooking gas cylinders sold for domestic use by 60% to 8 Egyptian pounds [That's from 5 pounds] a bottle, and doubled it for the bigger bottles used by businesses, an official at the supplies ministry said.
Although it marks a big rise, Egyptians had grown used to paying as much as 50 pounds a bottle last year on a black market where the state-subsidised gas bottles are sold at a mark-up. Those prices have now fallen to 10 to 15 pounds a bottle, according to Egyptian media reports.
There are a number of holes in the policy that fit in well with the Egyptian government’s ad hoc approach to economic policy. Moustafa Bassiouny, economist at the Signet Institute explains:
A) Raising the price of a gas cylinder from LE5 to LE8 is unlikely to result in any substantial savings for the government who are struggling to meet demand for fuel. [Rebel Economy: It's really just symbolic].
B) This type of fuel is predominantly used by the poor, while the wealthier have natural gas piped straight to their homes, while Egypt continues to heavily subsidise petrol which is, by definition, only used by the richest segments of the society (i.e., those who own cars). [RE: Egypt is effectively lifting subsidies to the wrong people].
C) This new policy change is fundamentally weak, regressive and ineffective, and still does not come as part of a comprehensive reform plan. So it fails financially and morally, in my opinion. [RE: Couldn't have put it better myself].
The biggest flaw in Egypt’s energy subsidy system (and many others around the world) is that it is a class-blind system that pays out more to support wealthier households whose fuel consumption is higher than in needier ones.
By lifting a subsidy specifically used by the poor, the Egyptian government is acting foolishly. The charts below show clearly how Diesel dominates the structure of subsidies, with LPG (used in cylinders) is a much smaller portion.
The Morsi administration would be well advised to follow through with its plan to introduce a new fuel rationing system from July 1 to raise prices of fuel used by the well-off.
But like most policy changes in Egypt, this could easily be delayed for months and even into next year.
The people at Cairo-based brokerage firm Pharos Holding have sent investors a thorough breakdown of the reasons behind Egypt’s diesel crisis.
Titled “Diesel Crisis: Unquoted Figures and Untold Stories. The Secret behind Diesel Shortages in Egypt” the document sheds light on the country’s fuel crisis.
Pharos Research sourced diesel import data from the main government statistics agency, the Central Agency for Public Mobilization and Statistics (CAPMAS) to understand the nature and magnitude of the current diesel crisis. They found that diesel import statistics are extremely alarming in terms of magnitude, reasons and implications.
Firstly: Diesel imports have been rising sharply and now make up about half of consumption, or around 9% of imports.
The media quotes Egypt diesel imports at around 25% of annual consumption. However, CAPMAS figures show that the true figure jumped to around 50.0% and accounted for around 9.0% of Egypt’s merchandise imports, up from only 2.5% in 2007.
Secondly: There is a growing rift between EGPC and foreign partners.
The reasons behind the surge in diesel imports and the current diesel shortage crisis is down to growing debts to foreign oil partners from the state oil company, Egyptian General Petroleum Corporation (EGPC).
But this rift has forced foreign partners to export their share of crude oil directly to third parties rather than sell it to the EGPC and risk further debt exposure. This has not only deprived Egyptian refineries from feedstock but triggered a surge in imports from foreign suppliers.
While the minister of petroleum said earlier this week outstanding liabilities to foreign partners have been settled ($ 6.5 billion), Pharos says liabilities have most likely been paid using the deposits of Qatar, Saudi Arabia and Turkey. Hence, Egypt has only managed to rollover rather than settle debt.
That’s not the only problem.
Although Egypt may have averted full erosion of its foreign reserves by delaying payments to foreign partners (yet at the expense of reputation and delays in upstream investments), it will not be able to defer payments to foreign suppliers (for imports).
What is alarming is that Egypt has run out of cash for diesel imports due to the inability of EGPC to secure payment guarantees from local banks, as Rebel Economy has reported before.
If this continues and foreign reserves inflows remain muted, Egypt will have no diesel for energy subsidies. It faces the prospect of food price inflation and social unrest that will pose huge challenges to political and economic stability.
This is exactly why Egypt has no choice over implementing energy subsidy reforms. The government must make normal Egyptians pay higher prices for fuel so that the administration can supply subsidies to those who really need them.
A disturbing, but unsurprising leak from an unnamed official in Egypt’s finance ministry reveals that funds allocated by the government for diesel fuel subsidies have run out for the current year, with the Cabinet scrambling to find a solution, according to Egypt Independent:
An official source within the ministry has said that meetings are being held with Ministry of Petroleum officials to solve the crisis, adding that the government’s subsidies for diesel fuel are estimated at LE50 billion.
The two ministries are considering opening an additional source of credit for diesel subsidies through a law giving the finance minister the power to approve additional credits.
Rebel Economy has repeatedly called for a swift overhaul of the energy subsidy system. Read here for a round-up of why.
But in a nutshell, and according to industry sources, in 2002, EGPC’s total debt stood at half a billion Egyptian pounds. In 2012, that debt pile has jumped to 200 billion pounds.
The organisation has also maxed out financing to fund oil and gas exploration from banks including National Bank of Egypt and Morgan Stanley.
Sources say the magnitude of Egypt’s debt is such that at BP’s global board meeting, Egypt’s debt repayment plan is brought up as a topic of discussion.
The finance ministry has already been effectively paying the oil ministry to buy its domestic energy needs either from foreign partners exploring in Egypt, or by importing it from countries including Algeria and Saudi Arabia. That was part of the reason foreign reserves fell so much.
The problem is based in the fact Egypt buys hydrocarbons at a high price, and sells at subsidised prices making it a costly system that wastes more cash than the country can afford. The energy subsidy system, which already swallows up to 20% of government spending, is also fundamentally flawed, and shortages have lead to a parallel black market.
An Egyptian radio station over the weekend revealed the cost of butane cylinders used by many Egyptians at home has now gone up to about LE70 and LE80 on the black market. A cylinder used to cost anywhere between LE8 and LE50 at the most.
Something has to give, but with further delays on implementing key subsidy reforms, it is not clear what this will be.
Funnily enough, the only official quoted in Egypt Independent’s story was Sherif Haddara, the new head of Egypt’s state-run oil company, the Egyptian General Petroleum Corporation. He quietly replaced Hani Dahi as the chairman of EGPC earlier this year, as Rebel Economy first reported this in November 2012.
Mr Haddara faces the country’s biggest challenge in managing the finances of the most indebted ministry in Egypt.
Over the weekend, Egypt released another “energy subsidy reform” announcement to add to the growing pile of releases that seem to disappear within days, with little follow-up.
Egypt is “working on a programme to cut the country’s energy subsidy bill by 50% over the coming five years and to compensate by raising Egyptian wages,” Ahram Online reported, citing the the state-run MENA news agency.
And with the government expecting the full year bill on energy subsidies to amount to $16.3 billion, a substantial proportion of the state budget, it’s no surprise that Egypt wants to make cuts. Especially as the system, as it stands, benefits the richest the most, rather than the country’s poorest who depend on cheaper fuel for their livelihood.
However, there is a big problem with this announcement. Egypt is effectively scaling back its energy subsidy reform plan.
Egypt had aimed, for a substantial part of 2012, to cut its energy subsidies by up to a third over the coming year as part of an ambitious plan to reform the economy.
More specifically, as Heba Saleh from the Financial Times wrote in October:
The reduction by E£40bn, or $6.5bn, in the current fiscal year, ending June 2012, is equivalent to roughly a third of the $17.2bn the government is estimated to have spent in the last fiscal year on fuel and electricity subsidies for industrial and domestic consumers.
Even almost a year ago, on New Year’s Day, 2012, Egypt came out with it’s New Years Resolution, as Reuters’ journalists wrote back then:
Egypt’s government will increase natural gas and electricity prices paid by heavy industries by 33 percent this month to narrow its growing budget deficit.
Economists say cutting energy subsidies, which represent about 20 of total spending, is one of the few practical options the country has to cut the deficit.
At the time, the higher rates were part of a plan to shave 20 billion Egyptian pounds ($3.3 billion) off the deficit.
But, unfortunately for Egypt’s already confused public, yet more mixed messages were to come. In September, Egypt’s government said it drafted a plan to reduce energy subsidies by 25.5 billion pounds ($4.2 billion). Here, again the cuts were suggested as within a year.
At this point, determining which cuts the government will actually make, and how much it will shave off the energy subsidy bill have become obsolete.
But what is clear is that the government last year had pencilled in a quite substantial and quick reform and that is now changing.
For example, if the government cuts the energy subsidy bill by $4.2 billion (according to the September announcement) that is equivalent to a 25% reduction of a $16.3 billion energy bill.
Cutting $6.5 billion from the total bill (according to the October estimate and based on a total annual energy bill of $16.3 billion), is equivalent to a near 40% cut of the total bill in a year.
So, if the government is suggesting cutting 50% of the bill but over 5 years, that’s a substantial markdown from earlier announcements, and should signal to readers that:
a) the government is realising the task of reducing subsidies quickly is much more difficult and contentious and is responding with softer plans, but more importantly,
b) while there is something to be said for a slow reform programme, Egypt is unlikely to recover quickly from its financial woes as long as energy subsidies exist in their current form, because they are such a huge weight on the budget.
So far, little real reform has happened. In November 2012, the Cabinet approved cutting subsidies from the high-end 95-octane gasoline, used mostly by the middle and upper class for luxury vehicles. But the more important coupon or smart card system that would see a nationwide impact on subsidy use is yet to be enforced.
Finally, we must consider the bigger picture in reforming energy subsidies. Right now, Egypt spends more on energy subsidies than on health and education combined. What if the government made real reforms quickly that meant Egypt’s poorest didn’t have to rely on the black market for their fuel needs, but also benefited from billions of dollars redirected into health and education – two vital pillars of a successful welfare programme?